Wheat leaders say prices are converging as they should
By MATTHEW WEAVER
The U.S. Commodity Futures Trading Commission has until Friday, Nov. 13, to decide whether to act on a Chicago Mercantile Exchange Group proposal to implement variable storage rates next year.
The rates are designed to help bring wheat cash prices and futures prices closer together.
The commission's agricultural advisory committee met Thursday, Oct. 29, to hear opinions on a Chicago Mercantile Exchange Group modification to wheat contracts, said Mike Dunn, chairman of the advisory committee.
"At the present time, this contract is not functioning the way we feel a futures contract should be functioning," Dunn told the Capital Press.
Under the modification, variable storage rates would be triggered when the basis is within 85 percent of full carrying charges. The implementation would occur in September 2010.
The CME Group proposed the modification Sept. 29. The commission has until Nov. 13 to accept the modification, reject it or do nothing, Dunn said. If the commission does not act, the modification goes into effect.
Dunn said the commission took "the extraordinary step" of putting the modification on its Web site and asked for comments.
"We're digesting all of the information we've got," he said. Other than accepting or rejecting the modification, the commission can ask for additional modifications or let the contract go through and then ask for additional modification.
"I don't see this as an end-of-the-line process," Dunn said. "We're going to continue to monitor this particular contract to see if whatever the final modification of the contract might be is effective or not."
Matthew Weaver is based in Spokane. E-mail: email@example.com.
Access the U.S. Commodity Futures Trading Commission Web site at www.cftc.gov.
Mike Dunn said concern about a lack of convergence for Chicago Board of Trade wheat contracts arose during his first meetings as chair of the advisory committee for the U.S. Commodity Futures Trading Commission in August 2006.
Dunn said he has consistently seen that the basis for convergence has not happened with the Chicago contracts. Producers complain they cannot use the contracts for price discovery because it is not the price they receive, he said.
"Producers are looking at a futures price, and they go to their local elevators and say, 'Here's what's being quoted on the Chicago wheat contract,'" Dunn told the Capital Press. "The elevator says, 'We know that's what's being quoted, but here's what we're going to pay you.'"
"A lot of the local elevators are very reluctant to do forward contracts, especially based upon that price," Dunn said. "They're looking more at what their local cash price might be."
In 2007, the Chicago Board of Trade merged with the Chicago Mercantile Exchange to become the Chicago Mercantile Exchange Group. At the time, Dunn indicated there were several reasons for the lack of convergence, but there also appeared to be a need to change the contract.
The CME Group made several modifications to the contract, adding additional delivery points, redefining the amount of the grain mycotoxin vomitoxin allowable and switching to a seasonal storage rate.
"That seemed to have some impact, but it still hasn't brought convergence within that wheat program," Dunn said.
A year ago, the commission established a subcommittee advisory group to the agricultural advisory group.
The subcommittee selected a proposal of going to a variable storage rate, recommending that when the basis price is within 80 percent of the full carrying charge, or the amount by which future shipments exceed, it triggers a variable storage rate.
The subcommittee originally recommended the change be implemented in December 2009. The CME Group representative on the subcommittee agreed with the idea, Dunn said, but didn't think it was feasible to implement it that soon. Subsequently, the group sent a contract modification to the commission that would trigger the variable storage rate at a level of 85 percent and go into effect September 2010.
What does industry say?
During the Oct. 29 meeting, the advisory committee heard many opinions about variable storage rates.
Matt Bruns of the National Grain and Feed Association recommended the variable storage rate change be implemented in December 2009 or no later than March 2010.
It will have some impact on market participants, he said, but the association believes that impact will be relatively small compared to the consequences for grain hedgers and producers if a solution is put off for several more years.
"We believe strongly the broader public good outweighs the concerns about potential negative impacts," Bruns said. "We would view this as a one-time, extraordinary action made necessary by the circumstances surrounding the wheat contracts."
Chad Burlet of Burlet Trading told the advisory group he disagreed with the notion that the solution needs to be rushed because it will take time to work.
"I can assure you once the decision is made, the market will price it within a day and begin to react," he said.
The change will have an impact on markets beyond the futures market, Burlet said, so the commission finds itself in "the inappropriate position" of choosing winners and losers, as the change would create a massive wealth transfer.
"I can't say whether the beneficiary or the harmed party would be the hedged or unhedged farmer or the hedged or unhedged miller," he said. "I think the law of unintended consequences would certainly rear its ugly head."
Burlet recommended the commission follow CME's suggestion to wait for a new crop for implementation, occurring in September 2010.
Joshua Kierley, vice chairman of the Wheat Futures Pit Committee, said the proposal is a well-intentioned but misguided solution to a serious problem, implemented at any date.
Variable storage rates will decimate liquidity, encourage market manipulation, confuse and destabilize an already skittish marketplace and discourage people from trading futures, particularly if they are a long hedger, he told the advisory committee.
In a market with many variables, full carrying charges, or full carry, is the closest thing spread traders have to an absolute and acts as a stabilizing force, Kierley said.
"It allows traders like myself to manage risk," he said. "Having that certainty contributes to a liquid market."
Kierley said early implementation of the storage rates would cause irreparable damage to the integrity and functionality of the wheat contracts.
"It would be similar to yelling fire in a crowded theater and then sealing the exits," he said. "The traders who were just burned by having the rug pulled out from under them are not going to stick around to get fooled again."
Departing National Association of Wheat Growers CEO Daren Coppock said lack of convergence impairs the functioning of the market.
It creates a situation where producers and commercial customers cannot hedge their risks and grain merchanidisers are not able to offer cash forward contracts, he said.
"Our marketing options get shrunk when the futures market is not performing adequately," he said.
While the proposal may or may not work, the association's consensus is that it's worth a try sooner rather than later, Coppock said.
"It's not a perfect (solution), it's a bit of a blunt instrument," he said. "But there are no perfect solutions."